Earlier this month, sources told Bloomberg News that a new iteration of the Switch console is coming from Nintendo (NTDOY 0.05%) sometime in 2021. It is rumored to have better graphics and a bigger OLED display than the first Switch, which launched four years ago in March.
Here's why investors should be excited about Nintendo's potential new Switch console, and why it sets the business up for success for many years to come.
What's in store
Nintendo is a notoriously secretive and slow-moving company. Similar to Apple, investors and consumers don't know the exact details of any new products until they are actually announced. With that being said, plenty of signs (like the Bloomberg story) point to a new console coming out sometime soon. Industry experts think it could support a 4K display when docked and a larger OLED display when in handheld mode, both of which would be significant improvements from the original Switch.
There is also speculation that a new Switch will have improved processing capabilities. For example, it may use Nvidia's (NVDA -2.51%) new Deep Learning Super Sampling technology, which would greatly improve the graphical capabilities when using the device in console mode. Whatever Nintendo chooses, any upgrades to power and display should help convince a wider range of gamers to give the Switch ecosystem a try. This would not only widen Nintendo's user base but also convince more third-party developers to release triple-A titles on the Switch, which in the past have stuck to either PCs or the more technically capable Xbox or Playstation consoles.
Why a new Switch is important
Historically, Nintendo has gone through extended boom and bust cycles with its gaming hardware. For example, the Wii had a short burst of success a decade ago, but then saw demand crater a few years after launch. Its follow-up, the Wii U, was a flop, selling only 13.5 million total units (for reference, the Wii sold over 100 million and the Switch has already sold 80 million units). The problem has been building a gaming ecosystem that has staying power and can be upgraded with better and better hardware iterations every few years, similar to what Sony has done with the Playstation consoles over the past few decades.
If this new Switch, whenever it comes out, can help dampen or eliminate the boom-bust cycle, Nintendo is setting itself up to consistently grow profits for years to come. A good way to track this is with the number of software sales on the Switch platform. So far, the Switch has grown the number of games sold every year since it launched. If unit sales grow over the next four, that is a strong indicator that the Switch is here to stay for the long haul. If they end up declining, that is a sign the boom-bust cycle hasn't been broken.
Nintendo has a market cap of $64 billion. Back out the $14 billion in cash on its balance sheet, and it looks like the market is valuing Nintendo's operating business at $50 billion. That gives the stock a price-to-earnings (P/E) ratio of 11.75, which indicates that investors think Nintendo's profits are not sustainable over the long run. However, if the Switch 2 (not the official name) is a success, Nintendo will grow its earnings and could also see its P/E expand once the majority of investors realize the sustainability of the Switch ecosystem.
Overall, news that a new Switch console is coming should excite any investor in Nintendo. We don't know when it is coming, its core features, or even if it will have the same mobile-to-console hybrid ability as the original Switch. But one thing is for certain: if Nintendo can end or dampen its historical boom-bust cycle, leading to more consistent profits and cash generation, the stock looks like a bargain trading at less than 12-times earnings.